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November 6, 2017

Go Big and Go Home: The Dicey Politics of Tax Reduction

Republicans are convinced that passing some sort of tax bill is crucial to their political future. And they may be right. The only thing worse than passing an unpopular bill may be passing no bill at all.

History suggests otherwise, however. Tax cuts are no golden ticket to election victory. Consider the Revenue Act of 1948, which was pushed through Congress by an insistent Republican majority and enacted over the repeated vetoes of an unpopular Democratic president.

The law seemed like a good idea at the time, but the 1948 tax cut proved to be a disappointment. Having delivered on their promise to give Americans a tax cut, Republicans still found themselves on the losing end of the 1948 election. Voters tossed them out and installed Democratic majorities in both houses of Congress.

Biggest Ever?

The 1948 tax cut was the third largest tax cut in American history, at least by most measures. It’s unlikely to cede that spot to the 2017 tax cut now taking shape, presidential Twitter promises notwithstanding. Late last month, President Trump vowed to deliver “the biggest TAX CUT in the history of our country,” but the legislation making its way through Congress seems likely to rank near the bottom of the top 10.

In a recent blog post evaluating the size of possible tax cuts, the Committee for a Responsible Federal Budget estimated that a bill reflecting major points of the unified framework would come in at number 8 on the roster of big tax cuts. If the law were actually made to conform with the budget resolution adopted last month, it would probably rank around number 12.

Ultimately, however, size may be overrated as a political virtue. The 1948 tax cut was very big, after all, but it still couldn’t shield Republicans from looming electoral disaster.

Crowding Out Reform

The cautionary tale of 1948 actually began three years earlier, when Congress adopted the Revenue Act of 1945. That law, passed just three months after the end of World War II, delivered the second largest tax cut in U.S. history, ranking just behind Ronald Reagan’s 1981 achievement.

The 1945 cut shaved $5.9 billion from existing tax revenue (about 13 percent of total revenue or 2.7 percent of GDP). The measure repealed the corporate excess profits tax entirely and reduced income tax rates for both individuals and corporations. It left most excise taxes at their wartime peaks, but it postponed a scheduled increase in the Social Security payroll tax.

The 1945 tax cut was big enough to imperil plans for more fundamental reform. Tax experts had a range of structural problems they hoped to address, but the hurried postwar tax cut left little room to maneuver. According to the economist Carl Shoup in a published review of the legislation, “The Revenue Act of 1945 makes no advance toward solving the problem of corporate taxation, high-bracket incomes, and other issues of equity.” Lawmakers had been forced to choose between delivering quick relief or well-considered reform, and they chose the former. It was not an unreasonable choice, given the heavy burdens of wartime taxation. But it came at a cost, both fiscal and political.

By providing such a large cut in 1945, legislators guaranteed that tax reform in 1946 (or later) would be harder. “The equity readjustment in 1946 will have to be made chiefly by putting on some one taxpayer what is taken off another, rather than by simply taking off taxes from someone,” Shoup wrote. Then, as now, lawmakers often used tax cuts to grease the skids for tax reform. But the 1945 tax cut promised to make that sort of maneuver more difficult in the future.

Corporate Integration

The law seemed especially likely to complicate plans for integrating the corporate and individual income taxes. “The action taken by Congress in the Revenue Act of 1945 suggests that it will be very difficult, if not impossible, to move far on this issue in the next year or two unless the solution is one that leaves on corporations en bloc about as much taxation as they will carry under the new revenue act,” Shoup wrote despairingly. “This act gives corporations all, if not more than, they could have hoped for in a quick tax reduction bill, while it does not move toward a solution of the corporate tax problem.”

Shoup was correct. As historian Steven A. Bank has recounted in From Sword to Shield: The Transformation of the Corporate Income Tax, it was not until 1954 that lawmakers were able to deliver even limited relief from the double taxation of corporate income, and then it was short-lived.

The corporate tax cuts enacted in 1945 were not unreasonable, but they robbed future reform efforts of vital political support. “The reductions for corporations in my opinion are as great as can be expected for a long time,” observed Sen. Robert A. Taft of Ohio (a Republican who, Shoup noted, “cannot be accused of an unsympathetic attitude toward the corporations’ complaint of double taxation”).

Shoup was more hopeful regarding the prospects for individual tax reform, especially at the top of the income scale where marginal rates were extremely high. Cutting rates in the upper brackets was immaterial from a revenue perspective, since they applied to very few taxpayers. But Shoup believed such rates, which topped out at more than 90 percent even after the 1945 cuts, were manifestly unfair — and more than a little dangerous. “Equity issues cannot be consistently ignored without shaking the morale of those who are disadvantaged and rotting the morale of those who are favored,” he wrote, “with incalculable consequences for the long-term future of the whole tax system.”

Second Bite at the Apple

Shoup was right to be worried about those top rates, which remained at more than 90 percent through the early 1960s. But tax relief more generally was hardly off the table. Indeed, it came roaring back as a political issue after Republicans swept the congressional elections of 1946, ending 13 years of dominance by Democrats on Capitol Hill.

The 1945 tax bill had been a bipartisan affair, but after the 1946 election, Democrats and Republicans charted different paths into the fiscal future. Republicans recommitted themselves to tax reduction, taking their cues from the last episode of postwar tax reform, when Treasury Secretary Andrew Mellon had engineered a rollback of the high rates enacted during World War I.

Democrats, meanwhile, assumed the mantle of fiscal responsibility. President Truman established himself as an aspirational budget balancer — which, in more practical terms, made him a firm opponent of further tax cuts, at least over the short term.

“It is the aim of our fiscal policy to balance the budget for 1947 and to retire national debt in boom times such as these,” Truman said when releasing budget projections in the spring of 1946. “In our present fight against inflation, fiscal policy has a vital role to play. A continuation of our present policy, which is to maintain the existing tax structure for the present, and to avoid nonessential expenditures, is the best fiscal contribution we can make to economic stability.”

As they ramped up their 1946 congressional campaign, Republicans seized on Truman’s resistance to further tax relief and promised to slash income taxes by an additional 20 percent. Polls suggested they were on the right track. In January 1946, before Republicans offered their tax cut plans, Americans said they trusted Republicans and Democrats more or less equally to keep taxes low (Republicans polled at 36 percent and Democrats at 31 percent). By September, however, the GOP had opened a sizable lead on the issue, with support from 42 percent of those polled, as opposed to 24 percent who trusted the Democrats.

Republicans rode the issue to victory, winning comfortable majorities in both houses; Democrats lost 111 seats in the House and 24 in the Senate. It was a rude shock for Democrats and especially for Truman, as his daughter later recalled: “My father awoke aboard his special train, en route to Washington, and discovered that he had a bad cold and a Republican Congress.”

Tax Cut Ideology

Once ensconced in the majority, Republicans set about delivering on their promise of a tax cut. Party leaders offered a justification that seems, in retrospect, to presage some of the “starve the beast” theories of the 1970s and 1980s. “The best reason to reduce taxes is to reduce our ideas of the number of dollars the government can properly spend in a year,” insisted Sen. Taft, “and thereby reduce inflated ideas of the proper scope of bureaucratic authority.”

Some other Republican leaders tried to make tax cuts a social and cultural issue, as well as an ideological one. “For years,” contended House Ways and Means Committee Chair Harold Knutson of Minnesota, “we Republicans have been warning that short-haired women and long-haired men of alien minds in the administrative branch of government were trying to wreck the American way of life and install a hybrid oligarchy at Washington through confiscatory taxation.”

As the tax cut made its way through Congress in 1947, it took on a more progressive cast. In the House, lawmakers replaced the flat, across-the-board 20 percent cut with a series of graduated reductions that expanded the cut for low-earners to 30 percent. The Senate took aim at the other end, scaling back the reduction to just 15 percent for high-earners.

Democrats were unswayed, and when Congress eventually passed the legislation and sent it to the White House, Truman vetoed it. The bill, he contended, provided “the wrong kind of tax reduction at the wrong time.”

The House sustained Truman’s veto, but only barely. Republican leaders drafted a new version, substantially identical to the first but with minor concessions, and sent it back to the White House. Truman vetoed this bill, too. The House voted to override, but this time, the Senate sustained the president’s veto.

Republicans still weren’t ready to give up. Convinced that tax cuts were both economically necessary and politically expedient, they took a third run at passing some sort of bill. House leaders added a variety of progressive refinements to the legislation, including an increase in the personal exemption from $500 to $600 (a popular move among liberals of the era).

The GOP effort got an additional boost from new budget projections, which promised a $6.8 billion surplus in the next fiscal year. That happy news weakened Truman’s claim to fiscal necessity, especially since the revised tax cut was expected to cost just $6.5 billion.

The House passed the new legislation easily by a vote of 297 to 120, thanks in large part to support from the ranking Democratic member of the Ways and Means Committee, Rep. Robert L. Doughton of North Carolina. The Senate then revised the bill slightly and passed it on a vote of 78 to 11, with 30 Democrats joining their GOP colleagues in support.

Truman vetoed this tax cut, too. This time, however, both houses of Congress voted to override, and the Revenue Act of 1948 became law.

The 1948 Election

As Republicans geared up for the 1948 election, they had reason to be hopeful. Truman was unpopular and widely regarded as a goner. And Republicans were happy to campaign on their marquee legislative achievement. In a July 1948 Roper poll, 69 percent disagreed when asked if Congress had cut taxes too much. Such numbers seemed to portend a happy result come November.

Republicans had a problem, however. Voters didn’t clearly associate tax reduction with the GOP, despite the party’s determined drive to enact it. As I noted in a 2006 article on the episode:

Broad Democratic support for the GOP tax bill had muddied the waters, diluting the GOP’s leverage on the issue. And while almost 70 percent of those polled wanted additional tax cuts, they also insisted that future relief favor the poor over the rich. Those sentiments did not bode well for the Republican tax agenda, which still featured a preference for lower rates on upper-income taxpayers. [Prior analysis: Tax Notes, Dec. 18, 2006, p. 1095.]

In addition to the distributive issue, spending concerns were also working against the Republicans. As tensions with the Soviet Union continued to mount, Americans were eager to ramp up military and diplomatic efforts around the globe. As I wrote in 2006:

Fully 72 percent were willing to pay more if the money would be used to send military aid to European countries threatened by the brewing Cold War. And 69 percent were even willing to pay new taxes in support of public diplomacy, as the United States set out to make its case against the Soviet Union with an aggressive public relations campaign.

Ultimately, the tax cut of 1948 could not save Republicans from the limits of their own agenda. Voters seemed to appreciate the tax cuts, thank you very much. But then, as now, they did not consider tax cuts to be especially important, at least when compared with other pressing issues. (In a poll last month by CBS News, 70 percent of respondents said other issues were more important than tax cuts.)

When the 1948 voting was finished, Republicans had lost 75 seats in the House and nine seats in the Senate, handing control of both houses back to the Democrats.

On the presidential level, Republicans lost a squeaker. The party had tried to pillory Truman for his reluctance to cut taxes. But Truman stood firm and managed to score one of the biggest upsets in American political history.

Looking back on his victory, Truman gave a nod to his opponents. “The luckiest thing that ever happened to me was the Eightieth Congress,” he said. Indeed, the president had memorably branded lawmakers as the “do-nothing Congress,” and voters seemed to agree.

Ultimately, the story of the 1948 tax cut — and the election that followed — should serve as a cautionary tale for today’s Republicans. To be sure, everybody likes a tax cut and now the GOP, still smarting from the failure of Obamacare repeal, is determined to avoid becoming the latest “do-nothing Congress.”

As voters made clear in 1948, however, something may be better than nothing but it’s not always enough.